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Executives

Peter J. McDonald - Chief Executive Officer, President and Director

Samuel D. Jones - Chief Financial Officer, Executive Vice President and Treasurer

Analysts

Unknown Analyst

Lance W. Vitanza - CRT Capital Group LLC, Research Division

SuperMedia LLC (SPMD) 2011 Earnings Call February 22, 2012 10:00 AM ET

Operator

Good morning, and welcome to SuperMedia's Fourth Quarter and Full Year 2011 Earnings Conference Call. With me today are Peter McDonald, Chief Executive Officer; and Dee Jones, Chief Financial Officer.

Some statements made by the company today during this call are forward-looking statements. These statements include the company's beliefs and expectations as to future events and trends affecting the company's business, and are subject to risks and uncertainties. The company advises you not to place undue reliance on these forward-looking statements and to consider them in light of the risk factors set forth in the reports filed by SuperMedia with the Securities and Exchange Commission. The company has no obligation to update any forward-looking statements.

A replay of the teleconference will be available at (800) 585-8367. International callers can access the replay by calling (404) 537-3406. The replay passcode is 47153760. The replay will be available through March 10, 2012. In addition, a live webcast will be available on SuperMedia's website in the Investor Relations section at www.supermedia.com. At the end of the company's prepared remarks, there will be a question-and-answer session. And now, I'd like to turn the call over to Peter McDonald. Peter?

Peter J. McDonald

Thank you, Paula, and welcome to our Q4 and full year 2011 earnings call. We appreciate your time and interest. I'll share some of my thoughts and then pass -- on the past year and then Dee will review the financials.

2011 was what we called internally, the year of construction. There were 3 principal themes to our work. First, reduce cost and improve the productivity by doing more with less. Second, reduce our debts to deleverage the company. And third, adopt and implement a strategic approach that will affect the transformation of SuperMedia from a provider of Yellow Pages products to a trusted marketing adviser helping small- and medium-size businesses retain and add customers using the full spectrum of digital and traditional media. I've spoken to you about our prior of each of these scenarios during prior quarterly calls. Now, let's take a look back at the results for the whole year.

We attacked our cost structure making disciplined decisions about products and activities that should be eliminated. And also work intelligently to create efficiency in how we operate. I'm pleased to say that all departments participated in these initiatives. And everyone deserves the credits for the company's 420-basis-point year-over-year margin improvement. As a result of these reductions, we delivered 2011 annual adjusted EBITDA of $602 million, 7.5% less than in 2010, despite an 18% year-over-year decline in adjusted revenue. As reported previously, 2010 included a $40 million favorable non-recurring non-cash resolution of state generating tax claims. We paid equal attention to our debt and capital structure. Again, the results are good. We reduced our debt by $426 million over the course of 2011.

In total, we have now taken down over $1 billion in debt since January of 2010. We intend to continue to pursue further reductions in 2012. Good work on expense and debt reduction has been complemented with a coordinated effort by marketing, sales and operations to transform our approach and value proposition for our clients. This is the path to improving our top line results. As a company, our purpose always has been to help small- and medium-sized businesses attract and retain customers through local media. That remains unchanged. Our job is to bring clients leads and customers, so that they can focus on what they do best: Running their businesses.

As we started 2011, we knew that while the fundamental purpose of our job may not have changed, the world in which we did our job had changed a lot. We would have to change the way we engage with our clients. The changes we had already made to offer websites and online Yellow Pages and search engine marketing as products along with the print Yellow Pages were not enough. We challenged ourselves to find out directly from business owners what they needed and how we could provide it. Business owners told us that they felt overwhelmed, that they did not understand all of today's local media choices. The confusion of online, social, mobile apps, deals, key words, SEO, blogs, tweets and so on. They did not have the training to deal with it. They did not have the time to deal with it. They did not have the staff to deal with it. The owners also told us that they still needed to reach new customers. They still wanted proof that their advertising worked. And that they would love to have someone they could trust to simplify things and take care of it all for them.

So we took their advice. We developed integrated solutions offering presence and promotion. Presence, listings across the major search engines and portals and other sites. Social media maintenance and updating for Facebook, as well as reputation monitoring, and websites optimized for the web but also companion mobile sites optimized for the explosion of the use of smartphone and tablet formats. In promotion, lead and call generating solutions combining search engine marketing syndication through local sites and mobile ad networks and even print Yellow Pages. And we included measurement and reporting to track the performance and prove the value of each item. We tested the solutions in different markets. And as I mentioned on our Q3 call, we launched formal trials of the new approach in 6 selected markets during the fourth quarter. We wanted to answer 2 basic questions: What works best for explaining the value of the new solutions to existing clients? What works best when calling on prospective clients?

I'm pleased to report that we found an approach that resonated with our media consultants and our clients. This -- the approach puts an emphasis on service, as well as solutions. Marketing and sales partnered with our operations teams to ensure we had a quality end-to-end service approach to deliver our solutions. From the analysis of each client before the appointment to the marketing -- with the marketing consultant to the meeting itself, to the fulfillment of the solutions, to the measurement and reporting, we are ensuring great service to complement our effective solutions. I'm very proud of the teamwork shown in this effort.

So how are we doing? Interviews with businesses who have experienced our new initiatives have been very positive. They said that we are moving from a product-centric approach that was "old, dated and tired" to a new approach that they described as new, relevant and service-oriented. Clients in the first-trial markets are seeing favorable return on investments as they track their performance measurement reports. But we do not have enough scale yet, and it's too early to project longer-term results.

Building upon the 2011 year of construction, 2012 will be a year of execution and transformation. In January, we began training managers and media consultants in the rest of our markets on our new approach. By early May, everyone will be certified so that change will arrive across the entire footprint over the course of the year. An important part of our methodology is that managers are certified on a new process first. They then have to ground and use it to close accounts in their markets before they can train and develop their teams. Leadership credibility and effectiveness are earned by proven results.

I emphasized earlier the importance of giving our clients mobile solutions that enable them to take advantage of the explosion in local search and shopping on mobile devices. We have applied the same belief to our company. Last fall, we introduced our redesigned Superpages.com mobile app for iPhone and Android smartphones, as well as iPads and Kindle Fires. Downloads of the applications continue to be robust, and it's easy to navigate by voice, by typing or fun to use real interface. We are generating well over a million calls a month for our clients from the apps. I invite you to download it and find a new neighborhood restaurant, compare area gas prices or look at today's local deals.

Another part of SuperMedia's transformation is the increasing importance of partnerships. As a trusted adviser across local media, we want to ensure that we bring our clients the best results. We are partnering with companies that offer the best solutions and widest reach to attract customers for our clients. Two examples: Earlier this month, we reach an agreement with Google to be one of a select number of participants in its AdWords premier SMB partner program. Google provides over 60% of web searches and over 85% of mobile searches. AdWords needs to be part of the mix for our search engine marketing clients. Through a close relationship with Google, we can offer additional value for our clients. Also for the many businesses that do not have the time, expertise or desire to self-serve, we take on the daily planning and analysis duties required by AdWords, and we provide integrated client reporting showing comprehensive measurement of how all business local media is performing, including AdWords.

Our second announced partnership this month was with YP.com. Our marketing consultants are now offering the YP.com online and mobile [indiscernible] of advertising solutions to provide additional leads and calls for our clients. We believe is a value advantage and a competitive advantage to offer a broader range of solutions to our clients, regardless of what brand is on the solution.

In January, the other members of the executive team and I completed a series of meetings with all of the SuperMedia employees around the country at which we each made presentations about the company. These sessions allowed us to thank the employees, recognize outstanding individual performances, review 2011 accomplishments and set up the company strategy and plans for 2012. The theme of the meeting was "It's Time." The entire SuperMedia team did its job during our 2011 year of construction, and now it's time to execute and transform in 2012. As we do, our focus on expense discipline and debt reduction will continue. In addition, we will complete the rollout of our new go-to market approach which we believe will enable us to better serve the needs of local businesses as their trusted media adviser, and to prove our value by the results we deliver and the service with which we deliver those results. We look forward to another productive year. And now, over to Dee.

Samuel D. Jones

Thank you, Peter, and good morning, everyone. Before we begin, I would like to mention that the results I will be speaking to this morning are primarily non-GAAP numbers. As I've mentioned in prior calls, our 2011 GAAP results are not comparable to 2010 GAAP results due to fresh start accounting. We have provided reconciliations of GAAP to non-GAAP results in the appendix of this presentation.

On to the 2011 financial results. Good quarter 2011 reported operating revenue was $384 million, and full year was $1.642 billion. The 17.9% decline for the quarter and an 18% decline for the full year compared to 2010. Ad sales for fourth quarter declined 16.1%. As I've mentioned on prior calls, our ad sales results for the year were negatively impacted by financially distressed single certified marketing representative firm in our third-party national sales channel. As of June 2011, all accounts had been transitioned to other CMR firms. Excluding this impact, 2011 full year ad sales would have declined 16.2% compared to 16.8% in 2010.

As we have mentioned before, small and medium businesses don't have time to focus on the complicated marketing that is involved in creating and maintaining websites, SEO activities, social media and the numerous other aspects to today's advertising marketplace. As Peter said earlier, that is why we have taken a new approach in how we sell marketing solutions. We are proactively reaching out to both our existing and new clients with an updated look and sales proposition that creates trusting relationships and most importantly, leads which translate the calls for our clients. As with any new go-to-market strategy like this, it will take some time before we see the actual impact flow to the top line.

As we move ahead in 2012, we will continue to look at every aspect of this business to keep costs down to offset the decline in the revenues. Our fourth quarter EBITDA was $139 million, a 7.9% decline compared to fourth quarter 2010 of $151 million. Fourth quarter EBITDA was negatively impacted by a non-cash adjustment of approximately $5 million associated with the discount rate utilized in calculating our Fast 112 LTD liability. Full year EBITDA was $602 million, a 7.5% decline compared to full year 2010 of $651 million. Fourth quarter EBITDA margin was 36.2%, a 390-basis-point improvement compared to prior period. Full year EBITDA margin was 36.7%, a 420-basis-point improvement.

As Peter mentioned, full year 2010 was favorably impacted by one-time operating tax settlements of approximately $40 million. In 2011, we worked hard at finding efficiencies in every portion of this business. Overall expenses, excluding depreciation, declined 23% compared to 2010. As a result of these cost initiatives, we were able to improve the EBITDA margins throughout 2011. For the year, bad debt was 3.9% of total revenues compared to last year at 5.2%. Full year free cash flow was $225 million, consisting of cash from operations of $244 million, less capital expenditures of $19 million. We remain focused on managing our debt. In the fourth quarter, we obtained a Second Amendment to our debt agreement, and we reduced our debt by $235 million utilizing $170 million of cash to affect below par payments. Total cash sweep payments made in 2011 were $156 million, including an additional ad par payment of $35 million associated with affecting the Second Amendment. This resulted in a total year in debt balance of $1.745 billion. We reduced our total debt obligation by over $1 billion in the last 2 years. As of December 31, 2011, our cash on-hand was $90 million. As you can see, we believe we were effective at reducing our debt in 2011 and will continue to do so in 2012.

This concludes the financial results report. We are now ready to take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Nick Germosic [ph] of Royal Bank of Canada.

Unknown Analyst

I was hoping you guys could talk about the mix between fixed and variable costs. And how -- with continued revenue clients of sort of 18% on a year-over-year basis, how we should think about the cost structure going forward? And just the obvious concern of negative operating leverage starting to hit the EBITDA margin.

Samuel D. Jones

Yes, [indiscernible] to question. We have discussed a little bit about variability versus fixed cost elements within that cost structure. As you saw from 2011 despite 18% declines in the revenue streams, we were able to get out the cost structure aspects of the business and find efficiencies, and take advantage of volume reductions in those things that came along with those revenue declines. As we look into 2012, we're still looking to get at efficiencies. We're still looking to maintain margins to the degree that we possibly can with respect to the top line, at the same time trying to transfer this business and drive better top line results. The variable aspect of the business, it's more of a tiered top activity. I mean, we do have Pay Per Click [ph]. We have some commission costs [indiscernible] account that goes along with the size and scale reductions, but there's not necessarily a direct one-to-one or a percentage that I can point you to. You do have to get the cost structure with actual initiatives and actions and activities will continue to do that as we look into 2012.

Unknown Analyst

In terms of thinking about just the overall expense structure now, could you point as to how we should think about the percent that is fixed and the percent that is variable?

Samuel D. Jones

Well, like I said, there's not an automatic percentage that you can point to. It depends on the activities and where the top line moves, how your customers -- what the customers are looking at and how you're approaching the marketplace. So you can't point to the direct percentage. As we look at, I guess maybe the best way to look at that -- the question is with respect to total margins at the end of the day. We were able to get into the 37% range versus 32% range in 2010. We're looking to find efficiencies in the operations and the aspects of the business to help us maintain margins. In those mid to high 30s range and as we find opportunities to improve against that, we'll look to take advantage of them.

Operator

Your next question comes from the line of Nadev Ezner [ph] of [indiscernible] Capital.

Unknown Analyst

Can you talk a little more about the ad sales number? And I guess the continued decline of that number especially in light of improving economic indicators in the last couple of months and especially the improvement that one season may [indiscernible] small business index which has historically been pretty correlated with ad sales for the industry.

Samuel D. Jones

Yes. With respect to the ad sales, as we saw through the year, the negative 16-ish, negative 15, negative 16, negative 17 top range of results, that -- we believe that continues to be influenced by the economic environment. If you understand our business and the sales cycle, it requires a good measure of confidence on the part of the advertiser to make that commitment as far as placing advertising on a 12- to 18-month commitment level. And so we tend to lag with respect to the economic indicators as far as recovering or coming out of some of the downturns. So we're still feeling the effects and in these fourth quarter results, we still see the effects of the economic environment that we've been experiencing for the last couple of years. It's good to see that some of the indicators in the economic environment are improving, moving the right direction. I think with SMBs, that's going to continue to be a slow process and a slow recovery. But we're hopeful that it will continue to hit in the right direction.

Operator

[Operator Instructions] Your next question comes from the line of Lance Vitanza of CRT Capital Group.

Lance W. Vitanza - CRT Capital Group LLC, Research Division

The first, I just want to confirm, it sounds like I ought to be adding back $5 million to my EBITDA calculation. That non-cash charge was -- would reduce the reported EBITDA in your press release, is that right?

Samuel D. Jones

Yes, on the quarter, we took a charge because of a change in our discount rate associated with our Fast 112 liability. The non-cash is there but there was approximately $5 million that negatively impacted the EBITDA on the quarter.

Lance W. Vitanza - CRT Capital Group LLC, Research Division

Okay, great. And then, could you discuss the incremental capacity that you have presently to tender for bank debt and how you expect that to roll forward over the next few quarters?

Peter J. McDonald

Yes, I mean, with the Second Amendment, we are allowed to utilize our excess cash for open market repurchases. We had a good transaction in the fourth quarter and affected the tender utilizing $117 million, which was the max at that point in time. With the fourth quarter, cash flow generation, you guys can do the math, but there's approximately $30 million of capacity at present that after we get through the process of reporting and after we get through the activities of certifications and stuff like that to meet the requirements, that we could utilize in the open market for repurchases. And we'll continue to look at that opportunity as we go forward. When you look out into the subsequent quarters and the period, it's basically that 32.5% of excess cash that's available to us so that we retain from our cash from operations, our free cash flows, that we can utilize for open market repurchases. We'll continue to watch the market and look at that capacity so that we can efficiently deleverage. So it's absolutely a focus for us. And we'll see how we're coming out relative to what's going on in the business and in the marketplace.

Lance W. Vitanza - CRT Capital Group LLC, Research Division

And I understand the percentage in terms of how to think about the size of the basket. But is there any limitation on the number times you can try to execute on that? I mean, could you do it every quarter if you chose?

Samuel D. Jones

Yes. I mean, we don't have a limitation as to the number of tenders that we can make relative to that.

Lance W. Vitanza - CRT Capital Group LLC, Research Division

Okay, great. And then lastly, just to sort of touch back on next question regarding the cost structure. I mean, if I look at cash OpEx, you took it down, or it went down 18% in 2010. It was down 25% in 2011. I mean, thinking absolute dollars, it fell by over $350 million in 2011. I mean, obviously, I would assume we can't expect anything like that for 2012. Is it possible for you to -- of that -- the 2011 reduction, is it possible for you to say how much of that represented removing fixed cost from the business versus just the variable reduction that would've been tied to the revenue shortfall?

Samuel D. Jones

Yes. Some measure of discussion in the 10-K that we'll be filing shortly, that reflects indication of how and what drove some of the expense impacts for the year. But when you look at the expenses in this business, you don't directly assign a variable or a fixed element, and we don't limit ourselves to looking at cost opportunities, in either of those means. So for example, we took earning that we put on the street, that's impacted not only by the content and the degree of content in a book, but it's also impacted by how many you put on the street, what markets do you distribute it in and the way they took those books. So it's not -- you can't correlate it directly and say, okay, this number of pages is direct or fixed, and this number of pages is variable. You got to look at this business as we transform, look the transform of this businesses. We have to look at every cost component not just the variable or the fixed by any means. We were successful in the last couple of years. We still believe we have some opportunity on the cost side of the business to find additional efficiencies, and we're going to have to -- and then, as the mix of business continues to evolve and change, we'll see influences there. You're right, the size and scale and the cost structure and the cost base has diminished over the last couple of years as a result of those efforts. But what I've done as far as looking for opportunity to get that cost, I would isolate for you exactly what's variable and exactly what's fixed. But you just can't do it in this business with this cost structure.

Lance W. Vitanza - CRT Capital Group LLC, Research Division

I understood. I mean, you guys have done a great job -- giving the margins up as far as you have. Now that said, I mean, if I look at Dex One, their margins are still north of 40%. Is there any structural reason that you couldn't ultimately get your margins to those levels? Is there something about your markets versus their markets? Or is that ultimately where you think you're headed?

Samuel D. Jones

Well, there are certain differences between our businesses and I can't speak to all the elements of Dex's business. But yes, we're in different markets. We have different -- somewhat different approaches, different mix of solutions for the advertisers. And so you'll see, a measure of difference. How you assign a differential in margins to that. I can't do it as far as speaking to Dex's cost structure. We're looking to optimize our margins as we move forward and as we work to transform this business. So we, as a company, are going to continue to look for efficiencies, look for ways to maintain and improve margins and whatever aspect of the business we're dealing with.

Operator

Your final question comes from the line of Sam Sakain [ph] of ALJ Capital.

Unknown Analyst

Just a question on the cost structure again on variability. Now when you guys sell an ad or directory listing, is it depending on the number of books you print or is it just by the cities or geographies covered?

Samuel D. Jones

No, the ad itself -- the cost of producing the ad is a function of the market it's in, the density of that market and how many places you placed that ad and what was purchased. The pricing around that is market-based pricing driven by the value proposition that underlies it.

Unknown Analyst

All right. So you guys are monitoring how many books are actually needed to be printed and kind of making more efficient that way?

Samuel D. Jones

Yes. I mean, we evaluate where we need -- where we have to place the books. And then secondly, where we get call counts and where we get the best value proposition for the advertiser as a result of having placed that ad. So we're always looking for the right mix, the right balance of printing books on the street from a cost perspective but maintaining and maximizing the value proposition for that advertiser.

Unknown Analyst

Got it. And just a last question on revenue mix. Is there kind of a ballpark number you can give us for what's directory revenues versus these SCO services?

Samuel D. Jones

No, we don't break the revenues down between that. We don’t look at the business in that fashion. I mean, our revenues, as a result of the sales of advertising solutions and advertising from -- for that advertiser. We simply deliver the value proposition to that advertiser and earning that revenue across multiple platforms, but we don't break it out between the various pieces.

Unknown Analyst

Then the bulk of the customers, would they be bundled in? I mean or they're just directory only? Are they just SCO services only? Or how can we look at that?

Samuel D. Jones

Well, you got clients in all of those categories. Obviously, we've been utilizing the print platform for the longest, and we're continuing to evolve and transform the business to that multi-platform approach.

Unknown Analyst

Okay. And then are you seeing, I guess, sound revenues in different geographies of the country? And just what areas you are seeing stronger?

Samuel D. Jones

I mean, geography doesn't -- it has seen some measure of variability. As we work through the economic downturn, we've talked in the past about the Florida and the California top marketplaces where we've seen more economic impact. And that continues to be the case. I think the recovery in those territories has been, and I would expect it to continue to be a little bit slower than in other markets.

Operator

At this time, there are no further questions. This concludes this morning's call. You may now disconnect. Thank you for your participation.

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